David Bruton Smith - Sonic Automotive, Inc. Jeff Dyke - Sonic Automotive, Inc..

Colin Langan - UBS Securities LLC Armintas Sinkevicius - Morgan Stanley & Co. LLC Rick Nelson - Stephens, Inc. Mark Jordan - Jefferies LLC.

Good morning, and welcome to the Sonic Automotive Third Quarter 2018 Earnings Conference Call. This conference call is being recorded today, Thursday, October 25, 2018.

Presentation materials which management will be reviewing on the conference call can be accessed at the company's website at www.sonicautomotive.com by clicking on Our Company, then Investor Relations, then Webcasts & Presentations.

At this time, I would like to refer to the Safe Harbor statement under the Private Securities Litigation Reform Act of 1995. During this conference call, management may discuss financial projections, information or expectations about the company's product or market or otherwise make statements about the future.

Such statements are forward-looking and subject to a number of risks and uncertainties that could cause actual results to differ materially from the statements made. These risks and uncertainties are detailed in the company's filings with the Securities and Exchange Commission. I would now like to introduce Mr.

David Smith, Sonic Automotive's Chief Executive Officer. Mr. Smith, you may begin your conference, sir..

Thank you. Good morning and welcome to Sonic Automotive's third quarter 2018 earnings call. I'm David Smith, the company's CEO. And joining me on the call today is our President, Jeff Dyke and our CFO, Heath Byrd. I will provide some brief comments and then turn the call over for questions.

In the third quarter of 2018, we reported $0.36 per diluted share from continuing operations on a GAAP basis and $0.43 per diluted share from continuing operations on an adjusted basis.

We were pleased with our performance during the quarter, which faced fairly tough comps due to the rebound effects of Hurricane Harvey in the prior year quarterly results. Some highlights for the quarter. EchoPark stores were up 221% after retailing 7,698 units during the quarter.

Overall, Sonic had a third quarter revenue and gross profit of $2.5 billion and $360.5 million respectively. Record third quarter pre-owned retail unit sales of 34,952 units, record third quarter F&I gross profit per retail unit of $1,505, record third quarter F&I gross of $98.1 million.

Our revenue and gross profit growth at our EchoPark stores continued during the quarter. The new Texas stores, which opened earlier this year, are performing very well, and as discussed in last quarter's call, the changes we made in the Denver market are generating outstanding results.

During the first week of October, we opened our first EchoPark location in Charlotte, North Carolina, and we're off to our best opening ever. And we'll open our next EchoPark location in the huge market of Houston, Texas, later in the fourth quarter.

On the franchise side, we expect our Land Rover open point in South Atlanta to open before the end of the year, and we are looking forward to a robust fourth quarter. In addition, Sonic's Board of Directors approved a quarterly dividend of $0.06 per share payable in cash for our stockholders of record on December 14, 2018.

The dividend will be payable on January 15, 2019. At this point, we would like to open up the call to questions..

The first question will come from John Murphy with Bank of America..

Good morning, guys. This is (3:56) here on for John..

Good morning..

First question – good morning. On new vehicle margins, really improved from last quarter and even on a year-over-year basis slightly.

So can you talk about the drivers of the improved performance there? I mean is the pricing environment is getting better or did you guys take any specific actions to address that part of the business?.

You bet. This is Jeff Dyke. Yeah, our BMW and Honda margins improved significantly. In particular, BMW's programs were strong and so we took advantage of that. And then we took a lot of action at our sales desk on Honda, while Honda margins continue to be an issue.

We just did a much better job at the sales desk managing our margin for Honda, pushing our prices up a little bit to the amount that Honda is not discounting any longer on the Accords in particular. And so, that's the big factor.

We'd reviewed that in our board meetings yesterday and the team did a really good job holding margin, and we believe we can hold that level of margin or better as we move forward..

So it's mostly is in of the pressures from BMW and Honda from last quarter versus overall improvement in pricing.

Is that the right way to think about it?.

Yeah, that's right. They're such a big portion of our overall volume. They are about 40% of our sales from a new car perspective. So, so goes Honda and BMW, so goes Sonic Automotive. And so we really put a big focus on that for the quarter and it made a big difference..

Okay. Makes sense. And then more of a high-level questions on the rising interest rates and affordability dynamics.

Do you guys see any impact on total consumer demand from rising rates or is it more that people just increasingly choosing to switch over to more affordable used vehicles?.

You want to take this?.

Yeah, well, I'll tell you. Obviously, it impacts our floorplan interests and some other variable products that we have. We expect three more increases in 2019 which we'll be budgeting for. So it impacts that. But I still think that the rates are low enough that it's not really driving any consumer demand in a negative way..

Okay.

And then on EchoPark, can you maybe talk about how your stores performed this quarter?.

I can. This is Jeff Dyke. Yeah, we had a great quarter. The store-level profitability was around $2 million. It takes about $4.5 million to $5 million to break it even. And so we didn't quite get to that number in the fourth quarter. We expect that to happen in the first or second quarter.

We opened our Charlotte store here on the 8th of October and we're off to our best start. That store is going to do over 200 retail units in a three-week period. It has a shot at breaking even in its first month, but probably in the second month it'll be profitable which is our best opening of a store yet.

And then we opened Houston on the 10th of December, and that is just going to be a beast. It's going to be a big store. We expect real high volume out of the store. And our Denver market is doing well. The Dallas market is doing well. Overall, the stores are doing great. We continue to make wonderful progress, and that team is excited about our progress..

Great. Thank you for the color. That's very helpful. And then just last question.

I might have missed it in your presentations, but in terms of your EPS outlook, you guys still expect $1.90 to $2 for 2018?.

Yeah, there's no change in our guidance..

Okay.

And that includes the EchoPark losses, correct?.

I'm sorry, it includes the past?.

Yes, it does..

Includes what?.

The EchoPark loss..

Oh, yes. Yes. Yes, ma'am..

Okay. Okay. Thank you. That's it from me..

Thank you..

Thank you..

The next question will come from Colin Langan with UBS..

Oh, great. Thanks for taking my question..

Hey, Colin..

Any color – hey.

Any color on the CEO transition? Any strategic view going on? Why the transition now? Just do you think things will be, David, do you have a different view on how the company should move forward?.

Thanks. Yeah, this is David Smith. I think mostly we're moving forward as planned with our strategy and on our focus, and we're just going to execute on the plan that we've already relayed to the Street. So, that's our plan..

So basically no change in the strategy moving forward?.

No. It's again, it's growing the core business, as always critical, growing EchoPark. We are putting a little bit more focus on delevering just a little bit, so you're going to see less capital allocation in your facilities.

We're really hammering down and only doing facilities that make sense for both the manufacturer and us, and so you're going to see some capital allocation going away from facilities and more toward some delevering..

Okay. Any thoughts on your online strategy? There are a lot of start-ups that are doing a lot. You can buy a car online.

I mean, how are you going to compete with that? I mean, what investments are you making there?.

Yeah, sure. This is Jeff Dyke. We'll launch Digital One-Stop either later this quarter or in the first quarter. That will allow the consumer to do an entire transaction online. Along with that, we'll launch our CarCash app. We'll allow the consumer to appraise the vehicle and we will be appraising the vehicle through our retail trade center.

I think we'll be one of the only ones out there that offers a non-third party appraisal process that goes along with the online app. That will make for a seamless transaction online, and we look forward to launching that. We'll do that in our New Braunfels store to start.

We'll geofence that in there, work through any issues or bugs that we have that we haven't figured out in testing, and then we'll roll that out to EchoPark. Once that's done, we'll begin to offer that at the Sonic locations..

Got it. And just lastly, just to clarify on EchoPark, I think you said you'd break even Q1, Q2.

That's the initial store and then what are the plans for same store?.

No, no, that's the whole enterprise..

Whole enterprise.

And how many?.

Yeah, it's real exciting for us. There will be eight stores by the end of the year..

And plans for next year or is that, you're going to stop at the eight?.

No, no, we have not announced that yet. We don't want to get out too far ahead of ourselves in terms of the next market, but we do have the next few markets selected and we'll announce that at the appropriate time..

But that wouldn't change the breakeven outlook Q1, Q2?.

Once we get it broken even, even if you open more stores, it'll continue to be profitable as we move forward. And that was the big deal for us. We gave ourselves a four-year outlook to get it profitable. We're going to hit that within a quarter or two, and then moving forward, as we open stores, it just adds to profitability.

We've figured that puzzle out now, and so now the question will be how many stores can we open and how fast can we open stores versus opening a bunch of stores that are just chewing up profitability. That's just not something we are willing to do. We wanted to get the model like.

We've done that now, and we look forward to announcing more markets as we move forward and increasing the velocity of stores that we open as we move forward..

Got it. All right. Thanks for taking my question..

The next question will come from Armintas Sinkevicius with Morgan Stanley..

Good morning. Thank you for taking my question..

Hi, Armintas..

Hey. Maybe you could talk about the new BMW models that are coming in. Obviously expecting a strong fourth quarter here, but just any sort of initial feedback as far as getting those models to the stores, initial customer feedback, et cetera..

Yeah, so look, we're very excited about the X5, but there's a stop sale on them, but that's just a short-term stop sale. That car is fantastic. I've reviewed the car and it's going to be unbelievable. The X7, which we'll start, we're taking orders for now and those order banks are filling up. We'll start receiving those cars in March.

Also, I cannot wait for that car to hit the ground. It's a wonderful car, and I've sat in that vehicle as well. The 3 Series, a totally new 3 Series, also going to be fantastic. Obviously, the 5 Series that already launched, a great vehicle. The 7 Series that's coming is a totally rebuilt 7 Series that I think really competes well with the S Class.

So, overall, that's right in our breadbasket. BMW is a big, big chunk of our volume and our biggest brand when it comes to profitability. The products that are coming are fantastic. They have done a great job, and we look forward to getting the cars on the ground and getting them sold..

Great.

And then in Houston, I know there's some tough comps coming up, or sort of in the midst of that versus Hurricane Harvey last year, but what are you seeing in that market maybe on a sequential basis?.

Yeah, so, look, September and October are the two tough months in terms of year-over-year comp. November, it started tailing off last year, and so we look for November and December to be really robust.

And at Sonic, you guys know this, December for us is just a huge month because of our brand mix and our market mix, and so we're expecting a really good fourth quarter. Our numbers all look good. October is feeling decent. It's not fantastic. It's a good month. EchoPark is doing extremely well. So we're looking for a really good fourth quarter..

Great. Thank you for taking the questions..

You bet..

The next question will come from Rick Nelson with Stephens..

Thank you. Good morning..

Hey, Rick..

Good morning, Rick..

I'd like an update, if you would, on driver select host strategies.

Are they fully in the Denver stores now and what you're seeing as you roll that into the stores?.

Yeah, the driver select strategy, Rick, is now in all the stores in terms of pricing and inventory, and we're loading in the EchoPark elements of EchoPark into the driver select stores, so it will convert fully to EchoPark in January. And the Denver stores are just rolling. Thornton this month's tracking 630 cars and profitability is fantastic.

The Centennial store, 250 to 300, I think, off the top of my head. Well over 100 down in Colorado Springs. So we're very excited. The market's really rolling. The Charlotte store, which opened with the strategy all from day one, we're pacing to do 215 cars in a three-week period.

So if you add the whole month, we'd be approximately 300 cars in our first full month and that's our best launch, bar none. And so we expect to have a huge launch in Houston. We're all converted. We're rolling, and the culture is fantastic. Everything's working great.

Just like you saw when we were in Dallas, except for now we're in a new store in Dallas and that store's 1,000 to 1,100 cars a month now..

Are you seeing that high attachment penetration in the Denver stores like you do in Dallas?.

In terms of warranty?.

F&I, yeah..

Yeah, it's actually higher. It's higher. It's in the upper 40s. So we're doing a better job in the original EchoPark stores than we're even doing in the Dallas store..

And the breakeven, as I recall, I think last quarter you had talked about breakeven in the fourth quarter..

That's correct..

And then, you're talking about first quarter of next year..

Yeah, Rick, give me first or second quarter. We generated $2 million in store-level profit in the fourth quarter, which was up from about $1.5 million in the third quarter, or excuse me, in the third quarter, which is up from $1.5 million in the second quarter.

It takes about $4.5 million to $5 million for us and we got the Houston store and the Charlotte store that we opened. It was just a lot of head count and carrying cost to get those open. But once that's done, the carrying cost for future stores will be able to cover the overhead.

So first, second quarter, sometime in there, we'll have it all profitable and rolling forward. And then, like I said earlier, it's just how many stores can we open and how fast can we open them.

It was real important to us, before we started opening more stores once we got past Houston, to have full coverage in profitability, so that moving forward, EchoPark's no longer a drain. It's adding profitability to the bottom line..

I guess I'd like some more color on that because the EPS loss widened, it looked like, $0.09 in the third quarter compared to $0.07 in the second..

It did. One of the things too is that we have so much walk-in traffic at the Dallas store that we hired about 35 sales associates to cover that. They go through 60 days' worth of training without any productivity. So, that's adding to that cost structure. That will change as we get out of October and into November.

They'll all start producing in November, so that'll help and that played a role in that..

And the buyers..

We're also increasing the number of buyers that we have to keep up with the volume. We're buying about 3,000 cars a month. We run EchoPark on a 20-day online, 20-day with pipeline, so 25-day supply total.

So we've got to have the right number of buyers and all of that's sort of adding into all of this, but we look for all of that to begin paying off for us as we move forward over the next couple of quarters..

Got you. And are you still looking....

And, Rick, this is David Smith..

Sure..

And another thing that I think is important to mention is that in Dallas, for example, we've proven we don't have to build a greenfield field from the ground up. So we took an existing old dealership and converted it very quickly into the new EchoPark Dallas.

So it's not like we've got to start from the ground up, wait a year or something to build new locations..

Got you. Okay. Thanks a lot, and good luck..

Thank you, Rick..

The next question will come from Bret Jordan with Jefferies..

This is Mark Jordan on for Bret. Good morning..

Hey, Mark..

Good morning..

Hello. So just jumping into the parts and service, it looks like we continue to see some favorable trends here in customer pay.

I think some of that is related to maybe replacing some warranty volume in the bays with the customer pay, but what else is driving the trends there?.

We're focused. We spent a lot of this year with our regional fixed teams working on some technology things, and we've got them off of that. They're focused and they did a really good job of operating service centers in the third quarter. We expect that to continue, up over 5% in customer pay.

We do have our bays back from all the warranty stuff that's been going on with the manufacturers. That's a big chunk of it right there, and we expect that to continue. We had a really good quarter. We expect to have another one in the fourth quarter in fixed..

And then – so when should we start to lap that kind of drop-off in warranty volume? Will it be Q2 of next year or is it Q1?.

Your guess is as good as mine looking into that crystal ball because the minute we think that everything's stopping, something else happens. BMW just recalled, I think, 1.6 million cars, and here we go again. So heck, the X5 launched, and there's a stop sale on it.

So it's just an ongoing part of the business, and I expect it to ebb and flow as we move forward. So who knows? I can't tell you..

Okay. Great. And then jumping into F&I, it kind of looks like your relationship here with JM&A is paying off and really helping drive higher F&I per unit, I think around $1,500 reported this quarter.

Thinking about the target of the $1,600 to $1,700 range, how quickly do we end up getting there and maybe end of next year?.

We'll see. It wasn't too long ago we were at $1,300, and we said, wow, wouldn't it be nice to get to $1,500? And the EchoPark stores are certainly helping there because we run north of $2,000, $2,200 a copy there. So, that's mixed into that $1,505 number that you see. We'll see. I mean, certainly $1,600 is in the numbers.

Whether that comes in the first part of next year or the latter part is probably the better thinking. But our relationship with JM&A, I just cannot tout them enough. They do a fantastic job for us. I wish we had been on with them a long time ago. They've just really done a good job for us, and it's certainly showing up in our performance..

Okay. Great. Thank you very much and look forward to next quarter..

Sounds great, Mark. Thank you..

At this time, there are no further questions. I'd like to turn the conference back over to Mr. David Smith for any closing remarks..

Thank you, everyone. Have a great rest of your week..

Ladies and gentlemen, thank you for participating in today's conference call. You may now disconnect..